System and method for determining the liquidity of a credit

ABSTRACT

The present invention relates to a credit index, a system and method for structuring a credit index, a system and method for operating a credit index, and a system and method for determining the liquidity of a credit.

RELATED APPLICATIONS

[0001] This application claims the benefit under 35 U.S.C. 119(e) ofU.S. Provisional Application Serial No. 60/295,856, filed Jun. 5, 2001and U.S. Provisional Application Serial No. 60/302,275, filed Jun. 29,2001.

FIELD OF THE INVENTION

[0002] The present invention relates to a credit index, a system andmethod for structuring a credit index, a system and method for operatinga credit index, and a system and method for determining the liquidity ofa credit.

BACKGROUND OF THE INVENTION

[0003] Various mechanisms exist for tracking a broad market using asubset of the available financial instruments. Such mechanisms include“indexes” (i.e., dynamic subsets) of the financial instruments and“baskets” (i.e., static subsets) of the financial instruments. Themarkets may typically include capital markets (wherein the market istracked using an index of stocks, for example) and credit markets(wherein the market is tracked using an index of bonds, for example).For the purposes of the present application, the term “credit” isintended to include, but not be limited to, a bond, a bank loan, and/ora credit derivative (e.g., a swap).

[0004] For example, a number of conventional stock indices exist (e.g.,the S&P 500, the Russell 2000, and the Russell 1000) which include asubset of stocks chosen to track a relatively large universe of stocks(e.g., small cap stocks, mid cap stocks, or large cap stocks). Theseconventional stock indices are typically priced on a continuous basis.More particularly, such conventional stock indices are typically pricedon a real time or quasi-real time basis.

[0005] Further, there exist conventional credit indices that include asubset of credits chosen to track a relatively large universe ofcredits. Such a relatively large universe of credits may comprise allinvestment grade credits in a given market or all high yield credits ina given market, for example. These conventional credit indices aretypically priced either: 1) once per month; or 2) more frequently using“matrix pricing” (wherein the pricing is carried out using a derivedpricing mechanism). While the timeliness of the pricing may be improvedby including fewer credits in the index (thus enabling more frequentpricing using more up-to-date data), the accuracy of the tracking of thebroad market by the conventional credit index has traditionally suffered(i.e., as fewer credits are included in the index the tracking error hastraditionally increased). Further still, some these conventional creditindices are not typically readily tradable in a widespread (e.g.,public) market, at least in part because the underlying credits are nottypically “liquid”.

BRIEF DESCRIPTION OF THE DRAWINGS

[0006]FIG. 1 shows a mechanism for determining a Liquidity Scoreaccording to an embodiment of the present invention;

[0007]FIG. 2A shows a spreadsheet depicting various calculationsaccording to an embodiment of the present invention;

[0008]FIG. 2B shows various formulas utilized in the spreadsheet of FIG.2A;

[0009]FIG. 3A shows a spreadsheet depicting various calculationsaccording to an embodiment of the present invention;

[0010]FIG. 3B shows various formulas utilized in the spreadsheet of FIG.3A;

[0011]FIG. 4A shows a spreadsheet depicting various calculationsaccording to an embodiment of the present invention;

[0012]FIG. 4B shows various formulas utilized in the spreadsheet of FIG.4A;

[0013]FIG. 5A shows a spreadsheet depicting various calculationsaccording to an embodiment of the present invention;

[0014]FIGS. 5B, 5C, and 5D show various formulas utilized in thespreadsheet of FIG. 5A;

[0015]FIG. 6A shows a spreadsheet depicting various calculationsaccording to an embodiment of the present invention;

[0016]FIG. 6B shows various formulas utilized in the spreadsheet of FIG.6A;

[0017]FIG. 7A shows a spreadsheet depicting various calculationsaccording to an embodiment of the present invention;

[0018]FIG. 7B shows various formulas utilized in the spreadsheet of FIG.7A;

[0019]FIG. 8 shows a mechanism by which risk factors are balanced tominimize the tracking error to the broad market according to anembodiment of the present invention;

[0020]FIG. 9 shows a mechanism for giving an investor alternative riskprofile options according to an embodiment of the present invention;

[0021]FIG. 10A shows a spreadsheet depicting an example ReferenceProfile associated with an embodiment of the present invention;

[0022]FIG. 10B shows a diagram depicting an example Reference Profileassociated with an embodiment of the present invention;

[0023]FIG. 11 shows a mechanism for carrying out a total return swapaccording to an embodiment of the present invention; and

[0024]FIG. 12 shows a diagram depicting a “net gain testing” processaccording to an embodiment of the present invention.

[0025] Among those benefits and improvements that have been disclosed,other objects and advantages of this invention will become apparent fromthe following description taken in conjunction with the accompanyingfigures. The figures constitute a part of this specification and includeillustrative embodiments of the present invention and illustrate variousobjects and features thereof.

DETAILED DESCRIPTION OF THE INVENTION

[0026] As required, detailed embodiments of the present invention aredisclosed herein; however, it is to be understood that the disclosedembodiments are merely illustrative of the invention that may beembodied in various forms. In addition, each of the examples given inconnection with the various embodiments of the invention are intended tobe illustrative, and not restrictive. Further, the figures are notnecessarily to scale; some features may be exaggerated to show detailsof particular components. Therefore, specific structural and functionaldetails disclosed herein are not to be interpreted as limiting, butmerely as a basis for the claims and as a representative basis forteaching one skilled in the art to variously employ the presentinvention.

[0027] In one embodiment, a “Liquidity Score” according to the presentinvention may be utilized to objectively measure the expected liquidityof a given bond (e.g., a bond in an index, a bond being considered forinclusion in an index, or any other desired bond). Such a LiquidityScore may, in general, approximate the ease of transaction executionassociated with the bond. In practice, such a Liquidity Score maycomprise a number produced at least in part by mapping key variablesagainst one another (e.g., via a continuous function).

[0028] More particularly, in one example (which example is intended tobe illustrative and not restrictive), a bond's Liquidity Score may becalculated using parameters including, but not limited to: a credit'ssize; the total issuance size of all credits of the issuer in an index;the age of the credit; the amount of equity that the issuer hasavailable; the profile of the debt (e.g. maturity, currency,subordination); the number of underwriters involved in the credittransaction; and/or the credit's sector categorization (e.g., industrysector (such as financial, non-financial, telecommunications, energy,etc.) and/or rating sector (such as AAA, BB, etc.)). In one specificexample shown in FIG. 1 (which example is intended to be illustrativeand not restrictive), the higher the credit's size and the issuer'soutstanding amounts, and the lower the credit's age, the higher theLiquidity Score.

[0029] In another specific example (which example is intended to beillustrative and not restrictive), the Liquidity Score may take intoaccount: 1) the bid/offer on the credit (e.g. the size of the differencebetween the bid and offer); 2) the “depth” of a market (i.e., how muchcan the market absorb without a significant price increase); 3) the sizeof a given credit transaction; and/or 4) the timeliness of theavailability of a credit.

[0030] In another specific example (which example is intended to beillustrative and not restrictive), the Liquidity Score may typicallytake into account: 1) the bid/offer on the credit (e.g. the size of thedifference between the bid and offer); and 2) the timeliness of theavailability of a credit, wherein the Liquidity Score may conditionallytake into account (in cases where an execution is large enough to pose apotential problem (e.g., to affect liquidity)) the “depth” of a market(i.e., how much can the market absorb without a significant priceincrease) and/or the size of a given credit transaction.

[0031] In another embodiment of the present invention, a liquid bondindex may be provided. In this regard, while the liquid index of thisembodiment is described below with reference to various specifics(including, for example, but not limited to: the number of bonds in thebroad index and in the liquid index, the various disqualificationparameters, the various formulas (e.g., the various functions andconstants), the Market Profile, etc.), it is noted that such specificsare provided as examples, and that these examples are intended to beillustrative and not restrictive. For example, the “Broad IndexComposition” parameter and the “Disqualification” parameter can becombined into one general parameter with subparts. As well, theseparameters can be combined with the “Liquidity Score” parameter into onegeneral parameter with subparts. Moreover, one or more the followinglisted subparts of each general parameter can be used to define thegeneral parameter (e.g. not every subpart is required to define thegeneral parameter). For example, in another embodiment, the “LiquidityScore” parameter can be composed only of the “incumbency premium.” Inyet another example, the “disqualification” parameter can be composed ofthe subpart “chronic poor bidding.” In yet a further embodiment, the“Broad Index Composition” can be composed of one or more subparts listedbelow such as “minimum face value” and “certain rating requirements.” Inany case, the liquid index of this example may use the following bondselection methodology:

[0032] Broad Index Composition. From bonds available in the market,select into a broad index (which broad index may be rebalancedperiodically (e.g., monthly) to add and/or remove bonds) the bonds whichmeet the following criteria (such a selection essentially identifies aQualified Entrant Pool):

[0033] Denominated in USD (for a US broad index); denominated in euro,eurolegacy-currency, and/or sterling (for a European broad index).

[0034] Minimum face value of $x (e.g., $500 mm) for a US broad index;minimum face value of y (e.g., 500 million or 500 million equivalent or200 million or 200 million equivalent or 100 million or 100 millionequivalent or 60 million or 60 million equivalent) for a European broadindex.

[0035] Corporate issuer (no government, sovereign, quasi-sovereign, orgovernment-backed debt).

[0036] No more than x time period since issuance (e.g., 5 years).

[0037] At least y time period remaining to maturity (e.g., 3 years).

[0038] The issuer (or the issuer's guarantor, in the case of a financesubsidiary) must be domiciled (and/or have most of its operations) incertain countries. For example: Andorra, Austria, Belgium, Denmark,Faeroe Islands, Finland, France, Germany, Gibraltar, Greece, Iceland,Ireland, Italy, Liechtenstein, Luxembourg, Malta, Monaco, Netherlands,Norway, Portugal, San Marino, Spain, Sweden, Switzerland, UnitedKingdom, Vatican City State, United States, Canada, and/or Japan.

[0039] Must meet certain rating requirements (e.g.: Must be ratedbetween AAA and BBB-by S&P and/or Aaa and Baa3 by Moody's if rated byboth agencies. If rated by only one agency, that rating must beinvestment grade. In one specific example, if the bond is rated byneither S&P nor Moody's, it is not a candidate. In another specificexample, the bond must be rated by both agencies.).

[0040] Exclude specific types of bonds (e.g.: i. Split-rated bonds(e.g., BB+ or below or Ba1 or below); ii. Floating rate notes; iii.Callables and Puttables (except for callables at make whole, which mayenter); iv. convertibles, preferreds, or bonds with other equityfeatures attached; v. MTNs; vi. Private placements (Rule 144A); vii.Dollar Eurobonds (for US broad index) [Globals may enter]); viii. debtissued by a sponsor and/or administrator of the liquid index (to helpeliminate any potential illegal solicitation under any appropriategovernmental and/or trading regulations); and/or iix. Yankees (i.e.,debt issued by an issuer domiciled outside the U.S. who issues dollaramount debt security and does not issue into the global market (i.e., amarket that trades in multiple places).

[0041] Include specific types of bonds (e.g.: i. Sinkables; ii.Step-ups; iii. Zeroes (but excluded from the liquid index); iv.Perpetuals).

[0042] Disqualification. From the Broad Index Composition, disqualifybonds that meet at least one of the following criteria:

[0043] Chronic poor bidding performance. If the bond's spread to thegovernment benchmark (e.g., 10 year treasury) that is bid by a specifiedtrader is x basis points (e.g., 250 basis points) over the averagespread for the broad index (e.g. corporate bonds) for y or more businessdays (e.g, 6 or more business days) over the prior z months (e.g., 2months), the bond is disqualified from the liquid index for a period ofj months (e.g., 6 months). An incumbent bond in the liquid index thatmeets this chronic poor bidding performance criteria will be removedfrom the liquid index. Of note, y may be selected so that the testoccurs over 2 or more different calendar weeks (to factor out thevacation of a trader, for example); z may be selected so that the testspans a change in months; and j may be selected to allow a bond to“cool-off” such that a market may re-develop for the bond. In general,this test may be used to examine a bond's recent history.

[0044] Lockout period. Any bond that falls out of the liquid index, butremains in the broad index, faces a x-month lockout period (e.g., 3month lockout period) before it can re-enter the liquid index. Of note,x may be selected to allow a bond to “cool-off” such that a market mayre-develop for the bond.

[0045] Minimum potential run. Any bond that enters the liquid index musthave a minimum potential run in the liquid index of at least x months(e.g., 6 months). Thus, in one example there must be at least 3 yearsand 6 months remaining to maturity when the broad index requirement isat least 3 years remaining to maturity.

[0046] Spread Volatility. The x-month (e.g., 3 month) par asset swapspread histories of all bonds in the broad index are scanned. From eachbond's spread history, a standard deviation of the daily changes iscomputed, and the natural logarithm of that value is recorded into avector. From the vector of such volatilities, a mean (μ) and standarddeviation (σ) are computed. Any bond whose volatility is greater than aspecific value, for example, μ+2.576σ (corresponding to a 1% percentileunder a normal distribution assumption), is disqualified from candidacyin the liquid index for a period of y months (e.g., 6 months). Anincumbent bond in the liquid index that meets this spread volatilitycriteria will be removed from the liquid index. A bond with fewer than xmonths (e.g., 3 months) of spread history in the index willautomatically test negative (i.e., will not be disqualified for thisreason). Of note, this test may be applied in the context of USD, LIBOR,and/or EURO basis points, for example.

[0047] Liquidity Score. From the Broad Index Composition, after applyingthe Disqualification criteria, every bond that is a qualified entrant tothe liquid index is assigned a Liquidity Score. This Liquidity Scoreapproximates the ease of transaction execution. The Liquidity Score maybe an additive composite of 3 factors:

[0048] Raw Score. The raw score 3-D surface is a mathematical functionof the age and size of the bond, with parameters constructed by studyingactual trading data and overall trader expertise. More particularly, inone example the Raw Score is determined using the formula:

RAW SCORE=max(0,3×ln(size)−15)×exp(−0.3×avg age)

[0049]  where avg age is the face-weighted average age of all theadd-ons plus the original principal that are part of the total bond(e.g., if a $1b face bond that is 1 year old had a $1b add-on 6 monthsago, the average age would be 0.75 years), size is the monetary value(in $ millions) of all the add-ons plus the original principal that ispart of the total bond, In is the natural log [i.e., the notation“ln(size)” means “take the natural log of the size”], exp is the base ofthe natural log [i.e., the notation “exp(−0.3×avg age)” means “raise thevalue of −0.3 times avg age to the base of the natural log], and thefunction max(0,3×ln(size)−15)×exp(−0.3×avg age) sets a floor for thevalue of RAW SCORE at zero. In another example (which example isintended to be illustrative and not restrictive), the constant 3 may bereplaced by any other desired constant (e.g., the constant 1.5), theconstant 15 may be replaced by any other desired constant (e.g., theconstant 6), and the constant −0.3 may be replaced by any other desiredconstant. Of note, the Raw Score decays with increasing age (due to theexp function) and increases with increasing size (due to the Infunction—which may provide a growth function which provides rapid growthfrom about 1 billion to about 2 billion dollars and less rapid growthabove about 2 billion dollars). In addition, other functions whichperform such manipulation may, of course, be used.

[0050] Issuer Premium. All issuers are ranked based on age-adjustedtotal public qualified debt (i.e., all of the debt they have issued thathas qualified for the index), where each bond's size is decremented by adecremeting term (e.g., the term exp(−0.3×avg age)). The aggregateage-adjusted debt of every issuer is calculated, the largest oneidentified (“MAX”), and each issuer is assigned a Model Issuer Premiumas follows:

MODEL ISSUER PREMIUM=12×(Issuer aggregate age−adjusted debt/MAX)

[0051]  Of note, the constant 12 in the formula above is given as anexample only, and any other desired constant (e.g., 10) may be used. Inaddition, the decremeting term exp(−0.3×avg age) is given as an exampleonly, and any other decrementing term using any desired constant(s)and/or function(s) may be used. In any case, the largest issue (of anissuer) is awarded the full Model Issuer Premium and every other issueof the issuer is awarded a fraction of the full Model Issuer Premium(“Applied Issuer Premium”) proportionate to the ratio of its RAW scoreto the largest RAW score of the issuer.

[0052] Incumbency Premium. Bonds that were members of the liquid indexin at least the prior month are assigned an “Incumbency Premium” toreflect the notion that a new entry candidate would have to outscore anincumbent by a reasonable margin of additional liquidity in order tojustify the expense of the trade (and/or to control turnover). In oneexample (which example is intended to be illustrative and notrestrictive), the Incumbency Premium is calculated as follows:

INCUMBENCY PREMIUM=6.0×exp(−0.3×avg age)

[0053]  In another example (which example is intended to be illustrativeand not restrictive), the constant 6 may be replaced by any otherdesired constant and the constant −0.3 may be replaced by any otherdesired constant. Of note, the Incumbency Premium decays with increasingage (due to the exp function) and any other functions which perform suchmanipulation may, of course, be used. Of further note, the IncumbencyPremium may be utilized to help achieve an optimum and/or desiredbalance between turnover (which, in one example, should be minimized),market representation, and tracking error (which, in one example shouldbe minimized). Finally, it is noted that all other bonds from an issuerwho has an incumbent bond may also receive a premium equal to (in oneexample, which example is intended to be illustrative and notrestrictive) 2.4×exp(−0.3×avg age). This “intra-issuer incumbencypremium” may help to facilitate a move to the on-the-run bond within alarge complex of debt from a single issuer.

[0054] Market Profile With Periodic (e.g., Annual) Updates. Profile thebroad index across industry sector and maturity dimensions by segmentingthe bonds into an A×B matrix (e.g., 3×2). For example, the matrix maycomprise 3 maturity classes (e.g., 5-10-30 years to maturity) on oneaxis, and 2 industry sectors (e.g., Financial and Non-financial sectors)on the other axis. Populate each cell in the liquid index with aselected number of bonds, with the number of bonds in the cell (from atotal of x bonds comprising the liquid index (e.g., 30 bonds to 100bonds)) determined by weighting each cell's numerical bond populationproportionately to the percent par amount outstanding in the same cellof the broad index. A new market profile may be created periodically(e.g., every November 1—a date roughly corresponding to the end of theunderwriting season) and the cell profile of the liquid index may bechanged to reflect the broad market changes, if needed.

[0055] Selection Process. The x bonds of the liquid index (e.g., the 30to 100 bonds) are chosen in the following three phases:

[0056] Start with the new month's index' initial composition with theincumbent bond set from the prior month. All eligible but non-incumbentbonds are subsequently rank-ordered by Liquidity Score. The universe ofnon-incumbent bonds that are considered eligible for entry into theindex consists of: new issuance during the month, and previously issuedbonds in each cell with a Liquidity Score ranking higher than thelowest-scoring incumbent bond in that cell.

[0057] Check to see if the cell is accurately populated with therequired number of bonds (based on the market profiling describedabove). If so, go to the next step. If not, remove bonds from the cellswith excess bonds by eliminating the bonds with the lowest LiquidityScore and add bonds to the deficient cells by choosing the bonds withthe highest Liquidity Score available for the cell from the eligibleset. Note that there can be fewer than x number of incumbents (e.g., 30to 100) at the end of a given period if an incumbent is disqualified dueto spread volatility or chronic poor bidding, for example. Conduct thispopulation process by rank ordering cells by average Liquidity Score andfavoring the cell with the lowest Liquidity Score first. Repeat the rankordering for each pass of the populating process (i.e., each pass of oneor more iterations).

[0058] Examine whether additional swaps of incumbent bonds fornon-incumbent bonds will increase the average Liquidity Score of theindex and, if so, execute those swaps (subject to any x-issue-per-issuerrule, wherein x is a number such as 1, 2, or 3, for example). Conductthis swap also by rank ordering cells by average Liquidity Score,favoring the cells with the lowest average Liquidity Score on each round(i.e., each pass of one or more iterations). When an incumbent issuer'snon-incumbent bond is considered for entry into the index, it mustsatisfy the following two conditions: 1) it must add to the averageLiquidity Score of the cell; and 2) it must add to the average LiquidityScore of the liquid index (i.e., the exiting incumbent bond must bereplaced by a non-incumbent bond such that there is a net gain in theaverage Liquidity Score of the liquid index from the coupledtransactions).

[0059] Of note, the initial selection process for an index (i.e., wherethere are no incumbents) is carried out in a similar manner withoutregard to any incumbent bonds.

[0060] Of further note, in another example the selection processdescribed above may be thought of in a simplified manner as consistingof ranking the Liquidity Scores of each bond in each cell and usingthose bonds (subject to the required number of bonds in each cell) withthe highest Liquidity Scores.

[0061] Bond Weighting. Every bond in the liquid index may be equallyweighted, on a par amount basis, to every other bond in the liquidindex. However, as stated in the rules above, by populating the largermarket segments with proportionately more bonds, the percent aggregatepar value weight of each cell in the liquid index may be broadlyproportional to the percentage par value weight of that cell in thebroad market. (In another example, every bond in a liquid index cell maybe equally weighted, on a par amount basis, to every other bond in thatcell (wherein improved market representation may be obtained)).

[0062] Although the above-described bond selection methodology(including Broad Index Composition, Disqualification, Liquidity Score,Market Profile With Updates, Selection Process, and Bond Weighting) wasillustrated with reference to carrying out the operation in a specificorder, any other desired order may, of course, be utilized foroperation.

[0063] Referring now to FIGS. 2A-7B, various spreadsheets providingadditional detail related to the above-described bond selectionmethodology using example bonds, values, and calculations (which examplebonds, values, and calculations are intended to be illustrative and notrestrictive) are provided.

[0064] More particularly, FIG. 2A shows (in cells A4-D49) a first stepin which: (a) various issuers included in a broad index are rankedaccording to the value of their decayed debt; and (b) each issuer isassigned a Model Premium (note that for the sake of simplicity 45issuers are depicted in FIG. 2A, although any desired number of issuersmay be included in the broad index and/or included in the processdepicted in this FIG. 2A). Further, FIG. 2B shows (in cells A4-D49) theformulas utilized in the spreadsheet of FIG. 2A. For example:

[0065] Model Premium for Ford Motors=(the Decayed Debt of FordMotors/the Decayed Debt of Ford Motors [the number 1 ranking issuer])×12

[0066] Model Premium of Wells Fargo=(the Decayed Debt of Wells Fargo/theDecayed Debt of Form Motors [the number 1 ranking issuer])×12).

[0067] Still referring to the Decayed Debt of FIGS. 2A and 2B, it isnoted that amounts depicted differ slightly due to rounding. Inaddition, it is noted that FIGS. 3A, 3B, 4A, and 4B provide more detailregarding the calculation of the Decayed Debt of FIGS. 2A and 2B.

[0068] More particularly, FIG. 3A shows (in cells H12-M30) a detailedcalculation example of the Decayed Debt of FIGS. 2A and 2B for one ofthe issuers (i.e., General Motors). Further, FIG. 3B shows (in cellsH12-M30) the formulas utilized in the spreadsheet of FIG. 3A. Forexample:

[0069] Decayed Size (or Decayed Debt) [of each individual creditissue]=Size [of the issue]×exp(−0.3×Age [of the individual creditissue]), wherein the Age equals a current date minus an issue datedivided by 365.25

[0070] Total Decayed Size (or Total Decayed Debt) [for the issuer]=Sumof Decayed Sizes [of each individual credit]

[0071] Still referring to FIGS. 3A and 3B, it is noted that the datevalues shown in FIG. 3B are intended to correspond to the conventionalnomenclature shown in FIG. 3A. In addition, it is noted that FIGS. 4Aand 4B provide more detail regarding the calculation of the Age shown inFIGS. 3A and 3B.

[0072] More particularly, it is shown in FIG. 4A (in cells H34-L47) howadd-ons to three of the General Motors credits shown in FIG. 3A (i.e.cells L20, L21, and L23) affect the Age calculation. This modified Agecalculation is shown in detail in FIG. 4B, where it is seen (withreference to the first General Motors credit [i.e., Secid=27050415], forexample, that:

[0073] Total Size [identified in the Size Change column]=the size of thecredit+the size of the add-on

[0074] %Size [of the credit or of the add-on]=size of the credit [or ofthe add-on]/Total Size

[0075] Term [of the credit or of the add-on]=(a current date−issuedate)/365.25

[0076] Term [of the combined credit with add-on; as shown in the Agecolumn in FIG. 3A] (the term of the credit×the % size of thecredit)+(the term of the add-on×the % size of the add-on)

[0077] Referring now to FIG. 5A, it is seen that this Fig. shows (incells B10-H32) the steps for calculating a Liquidity Score for a bond(including the step of assigning specific premiums to each bond fromeach issuer based on the % of each bond's Raw Score relative to the topscoring bond from each issuer).

[0078] More particularly, FIGS. 5B, 5C, and 5D show (in cells B10-H32)the various formulas used in the spreadsheet of FIG. 5A. For example (inconnection with three AT&T Wireless bonds):

[0079] A Raw Score for each of the three bonds is calculated using theformula: Raw Score=exp(−0.3×the age of the bond))×max (0,3×ln(the sizeof the bond)−15))

[0080] A Maximum Raw Score selected from the three Raw Scores isdetermined The bond with the Maximum Raw Score gets an IncumbencyPremium=6×exp(−0.3×the age of the bond).

[0081] The remaining bonds (i.e., the bonds that do not have the MaximumRaw Score) get Incumbency Premiums=Maximum Incumbency Premium×0.4

[0082] Each bond gets assigned an Applied Issuer Premium as follows: thelargest issue (of an issuer) is awarded the full Model Issuer Premiumand every other issue of the issuer is awarded a fraction of the fullModel Issuer Premium (“Applied Issuer Premium”) proportionate to theratio of its RAW score to the largest RAW score of the issuer. Note thatthe “‘Issuer Premium’!$D$21” factor of the spreadsheet of FIG. 5Drelates back to the spreadsheet of FIG. 2A.

[0083] Each bond is assigned a Liquidity Score=the bond's Raw Score+thebond's Incumbency Premium+the bond's Applied Issuer Premium

[0084] Referring now to FIG. 6A, a spreadsheet showing the calculationof % weighting of various bonds (i.e., the 5 unnamed bonds in rows 7-11)is provided. More particularly, FIG. 6B shows the formulas used in thespreadsheet of FIG. 6A, including:

[0085] Calculating Market Size for each of the bonds as MarketSize=Size×Present Value

[0086] Calculating Total Market Size of all of the bonds as Total MarketSize=the sum of the Market Sizes of each of the bonds

[0087] Calculating the % Market Size for each of the bonds as % MarketSize=Market Size of each bond/Total Market Size

[0088] Referring now to FIG. 7A, a spreadsheet showing the calculationof Pure Market Weighting of various bonds (i.e., the 5 unnamed bonds inrows 7-11) is provided. More particularly, FIG. 7B shows the formulasused in the spreadsheet of FIG. 7A, including:

[0089] Calculating Market Size for each of the bonds as MarketSize=Size×Present Value

[0090] Calculating Total Market Size of all of the bonds as Total MarketSize=the sum of the Market Sizes of each of the bonds

[0091] Calculating the % Market Size for each of the bonds as % MarketSize=Market Size of each bond/Total Market Size

[0092] Calculating the Market Weighting of each bond as MarketWeighting=Face (of each bond) x Present Value (of each bond)

[0093] Calculating Total Market Weighting of all of the bonds as TotalMarket Weighting=the sum of the Market Weights of each of the bonds

[0094] Calculating the % Market Weighting for each of the bonds as %Market Weight=Market Weight of each bond/Total Market Weight

[0095] Of note, in connection with FIGS. 6A, 6B, 7A, and 7B, the “face”is the amount outstanding and the “size” is an equal weight factor. Offurther note, columns “E” and “H” of FIGS. 6A, 6B, 7A, and 7B reflectequal par weight (which type of weighting may be used for a liquidindex, for example) and columns “J” and “K” of FIGS. 7A and 7B reflectactual face amounts (which type of weighting may be used for a broadindex and/or a Total Return Swap, for example).

[0096] In another embodiment, a credit index according to the presentinvention may provide a mechanism to satisfy the need for a benchmarkwhich: 1) accurately and timely tracks a broad market; 2) has“investor-friendly” features; and/or 3) may be used for performancemanagement to enhance risk exposure and expected return.

[0097] In one example, which example is intended to be illustrative andnot restrictive, such a benchmark may include, but not be limited to, alarge cap or high yield liquid index of an investment grade which may betimely and frequently priced (e.g., essentially continuously inreal-time (such as by the split second or by the second), in a delayedmanner in quasi real-time (such as by the minute or by the hour), afixed number of times during the day (such as 5 times daily), and/ordaily). Such frequent pricing may permit index users to respond morequickly to market moves.

[0098] Further, the “investor-friendly” features may include: 1) anindex which is open and transparent (e.g., data at index, sub-index,and/or bond level may be available to an investor), 2) an index which isaudited (e.g., by a third party), 3) an index which is governed by apolicy committee (members of which may be independent of the partyinitiating the index), 4) an index which is easy to understand (e.g., arule-based index with commercial market applications); 5) an index witha web-based interface (e.g., one or more web pages) for providing marketanalytics (e.g., real-time and/or historic performance on any index orsub-index down to the individual bond level; 6) an index for which indexquotations are available on one or more major financial media providers,and/or 7) an index run by a market leader with a long term commitment.

[0099] In another embodiment, a tradeable, liquid credit index accordingto the present invention may provide a mechanism by which risk factorsare balanced to minimize the tracking error to the broad market. Moreparticularly, as seen in one specific example shown in FIG. 8 (whichexample is intended to be illustrative and not restrictive), the designof a tradeable, liquid credit index according to the instant inventionmay recognize different risk factors (e.g., Ratings, Sectors, andMaturity) in a multi-dimensional array used in constructing an indextracking algorithm. Each cell (or “sub-index”) of the array may bearranged in a manner similar to the manner in which a given market dealswith risk. For example (which example is intended to be illustrative,and not restrictive), if a given cell has a particular weight inrelation to the broad market, the tradeable, liquid credit index of thepresent invention may weight that cell with the same weight given by thebroad market and certain credits may be selected into the cell andindividually weighted so that the overall tradeable, liquid credit indextracks the broader market (which itself may be represented by a broad oraggregate credit index for tracking purposes). In another embodiment, atradeable, liquid credit index according to the present invention mayagain provide a mechanism by which risk factors are balanced to minimizethe tracking error to the broad market. More particularly, as seen inFIG. 8, the design of a tradeable, liquid credit index according to theinstant invention may recognize different risk factors (e.g., Ratings,Sectors, and Maturity) in a multi-dimensional array used in constructingan index tracking algorithm. In this example (which example is intendedto be illustrative and not restrictive), each row, column and height maybe arranged in a manner similar to the manner in which a given marketdeals with risk (e.g., the rows, columns and heights may form “buildingblocks”—used for matching the profile of a market).

[0100] In another embodiment, a credit index according to the presentinvention may provide a financial vehicle that is appropriate to theincreased credit specialization spreading across the fixed incomemarkets as sophisticated managers are developing expertise to separatethe management of duration/curve risk from credit risk.

[0101] In another embodiment, a credit index according to the presentinvention may provide a mechanism by which index quotes representexecutable pricing, rather than indicative levels.

[0102] In another embodiment, a credit index according to the presentinvention may provide a mechanism by which credits within the index arepriced individually (e.g., by a trading desk), rather than via matrixpricing.

[0103] In another embodiment, a credit index according to the presentinvention may provide a mechanism by which transaction costs areincorporated into the calculation of the credit index (e.g., credits mayenter the index on the offered side while being marked on the bid side).While such incorporation of transaction costs may generate moreconservative returns, it should report a level that an investor is morelikely to experience while attempting to outperform the market.

[0104] In another embodiment, a credit index according to the presentinvention may comprise a liquid index that is a subset of a broader,aggregate index. Such a liquid index may represent the most liquid partof a broad market (e.g., a credit market), have a low tracking error,and/or be balanced and representative of the broad market.

[0105] In another embodiment, a credit index according to the presentinvention may comprise a fixed (or variable) number of credits which: 1)are maximally representative of a broad market; and 2) have the highestLiquidity Score.

[0106] In another embodiment, a credit index according to the presentinvention may comprise a fixed (or variable) number of credits (e.g.,bonds) that are chosen in a balanced manner.

[0107] In another embodiment, a credit index according to the presentinvention may comprise the top liquid credits in a broad market.

[0108] In another embodiment, a credit index according to the presentinvention may provide a default probability that is lower than the broadmarket (in general, average default probability increases with the ageof a bond and decreases with minimum rating requirements on an index).

[0109] In another embodiment, a credit index according to the presentinvention may provide a mechanism for balancing diversification withliquidity by utilizing the inventive Liquidity Score concept. Moreparticularly, an objective of diversification is replication of anaggregate market, a manner of achieving diversification is by bringingnew issues into the index (e.g., on a monthly basis) and by balancingindex components between sectors (to gain exposure to the entire broadermarket), and a result of diversification is a low tracking error. On theother hand, an objective of liquidity is to produce a tradeable andliquid index, a manner of achieving liquidity is by employing theLiquidity Score concept and by bringing new issues into the index whichare more liquid under the Liquidity Score concept than existing issues.In addition, limited “slippage” may be employed as a variable to controlthe turn-over of credit into the Indices.

[0110] In another embodiment, a credit index according to the presentinvention may provide a mechanism for balancing diversification withliquidity and administrative costs (associated with rebalancing theindex by transferring credits into and out of the index) by maximizingthe liquid credits in the index while minimizing the transference ofcredits into and out of the index.

[0111] In another embodiment, a credit index according to the presentinvention may provide a flexible and transparent mechanism for giving aninvestor the opportunity to reach a number of objectives, including, butnot limited to, maximization of total return, leverage, maturityflexibility and principal protection.

[0112] In another embodiment, a family of credit indices according tothe present invention may provide a mechanism for giving an investoralternative risk profile options with regard to varying terms andstructure and which offer a range of risk and return, as seen in FIG. 9,for example.

[0113] In another embodiment, a credit index according to the presentinvention may provide a mechanism for essentially tracking an allocationprofile of a market (e.g., a sector rating of the market) whilemaintaining in the index the top liquid credits available in the market(i.e., the top liquid credits from the liquidity profile of the market).

[0114] In another embodiment, a credit index of the present inventioncan have a number (e.g., 4) of large “super-sectors” (e.g.,Consumer/Finance/Industrial & Utilities/Telecom & Technology) dividedinto a number (e.g., 22) of separate industry sub-sectorclassifications. Further, a number (e.g., 11) of these sub-sectors maybe divided into further sub-classifications. This allows detailedmulti-layer analysis of the index that is believed to be necessary inthe increasingly sophisticated credit market.

[0115] In another embodiment, a credit index of the present inventioncan utilize a Market Profile (or “Reference Profile”) as shown in FIG.10A. More particularly, as seen in this FIG. 10A, and in FIG. 10B, theReference Profile may have four sectors along one axis (e.g., Consumer,Finance, Telecommunications/Technology, and Industrial/Utility) andthree maturities along the other axis (e.g., 5 year, 10 year, and 30year). In addition, FIG. 10A shows various illustrative compositions ofthe above-mentioned Reference Profile.

[0116] In another embodiment, a credit index of the present inventioncan have a framework (e.g. a sector framework or a ratings framework)which is sufficiently similar to the framework used by a credit analysisorganization (e.g., Moody's) to permit the calculation of a diversityscore essentially continuously may be provided.

[0117] In another embodiment, a credit index according to the presentinvention may provide a more efficient mechanism for engaging in variousinvestment strategies, including, but not limited to, total returnswaps, total return index-linked notes, principal protectedindex-participation notes, and any desired derivative product (such asoptions, futures, and swaps, for example).

[0118] In one specific example, which example is intended to beillustrative and not restrictive, investors sharing a bullish view on acredit market (e.g., the European credit market, the U.S. credit market,or the Asian credit market) could enter into a total return swap (“TRS”)in order to participate in potential market moves. Under this strategy,investors may assume diversified exposure without initial cash outlayand investors may gain credit exposure without costly replicationstrategies and specific credit analysis expertise. Thus, this strategymay suit risk takers with limited liquidity while providing full upsideand downside exposure. Because of hedging ability with the presentinvention, there may no longer be a need to match orders in order toexecute the various investment strategies previously discussed.

[0119] More particularly, as see in FIG. 11, the total return swapitself may initially be designed as a fixed term structure (e.g., 6months) wherein the investor receives/pays the appreciation/depreciationof a liquid credit index according to the present invention at maturityaccording to a predetermined formula. In exchange, the investor may paythe counterparty an agreed reference amount (e.g., a 3 month Euribor orLIBOR). The total return on the liquid credit index may comprise anyprice changes over a given period plus any accrued interest plus anycoupon payments and reinvestment income all divided by the price and theaccrued interest at the beginning of the given period. The pricing mayincorporate bid/offer spread on cash, as well as rebalancing on indexand financing spreads. In another embodiment, the total return swap maybe structured with several maturities.

[0120] In another embodiment, the present invention may he utilized inconjunction with one or more credit oriented Exchange Traded Funds(“ETF's”). Such credit oriented ETF's may include, but not be limitedto, bonds, bank loans, and/or credit swaps.

[0121] Of note, the credit ETF according to the present inventionmay: 1) provide the ability to expand and contract to keep price in linewith the underlying credits; 2) provide substantial liquidity; 3)provide diversified credit exposure, including long exposure and theability to “time the market” by coming into and out of the market(particularly to investors lacking the resources to gain such exposureon their own); and 4) provide liability management, wherein exposure tothe “class” of holders of the ETF is controlled and wherein exposure isconcentrated as desired.

[0122] In another embodiment, a credit index according to the presentinvention may use a “roll” technique, wherein some or all of the creditswhich are bought and sold (i.e., moved into the index and moved out ofthe index) at a given time (e.g., during a periodic rebalancing) arebought and sold in one transaction. The periodic rebalancing may occurat any desired time, including, but not limited to, daily, weekly,monthly, quarterly, semi-annually, or annually.

[0123] In another embodiment, a credit index according to the presentinvention may use a “cheapest to deliver” technique, wherein: 1) theindex is weighted towards the largest issuers in a market and/or towardsparticular maturities of credits issued by such issuers; and/or 2)credits of same issuers are normalized through a mathematicalrelationship to improve liquidity. The normalization of credits ofdifferent issuers may be used as a substitute for the Liquidity Score ofthe present invention or as an element of the Liquidity Score of thepresent invention.

[0124] In another embodiment of the present invention the rules of theindex may be governed by a Policy Committee (“Committee”). The Committeemay be composed of a predetermined number of external members (i.e.,members unrelated to a party initiating the index). In one specificexample, the predetermined number may be 50% of the full Committee. TheCommittee's decisions may be binding, and decisions may be required tobe made with unanimity. The Committee may meet at least once a year toreview the rules and composition of the index in the light of changingmarket structure (though the Committee may also strive for continuity).If there are exceptional circumstances that affect the entire market ora particular bond, any member may be able to call a meeting to request aruling from the Committee as to whether certain bonds should be excludedfrom the index. In one specific example, the concern may be to ensurethe liquidity of the bonds in the index. Further, a ruling may berequested if a bond trades below a predetermined percent (e.g., 50%) ofpar or accreted value for a predetermined number of days (e.g., 20consecutive business days) after the value is verified with externaldata sources (e.g., Bloomberg, IDC) if available. Further still, aruling may be requested if a spread widens more than a predeterminedamount (e.g., 250 basis points) vs the index's spread.

[0125] In another embodiment of the present invention the rules for thebonds associated with the broad index could be the same as or differentfrom the rules for the bonds associated with the liquid index and therules for bonds already in an index (e.g., the broad index and/or theliquid index) could be the same as or different from the rules for bondsbeing considered for inclusion in an index (e.g., the broad index and/orthe liquid index).

[0126] In another embodiment of the present invention the “chronic poorbidding performance” test may be modified such that if a bond testspositive on the last trading day prior to the first of the month, thebond is disqualified for a shorted period of time (e.g., only thatcoming month). In addition, liquid index incumbents that test positivemay remain members of the liquid index.

[0127] In another embodiment of the present invention a credit indexwhich may be used by a portfolio trader, which may be incorporated intoa number of different investment/trading strategies, which may be usedwith one or more collateralized debt obligations (“CDB's”), and/or whichprovides access to a liquid asset is provided.

[0128] In another embodiment of the present invention the LiquidityScore may be utilized to determine a bond's liquidity in place of and/orin conjunction with volume trading data (which may be difficult toacquire). In another embodiment of the present invention weighting ofthe liquid index is not necessarily performed using market weighting(wherein there may be concentration risk (e.g., the need to buy a largedollar amount of one or a few bonds) when a big sector has relativelyfew bonds qualified for inclusion). Rather, or in conjunction with suchmarket weighting, the liquid index may use weighting which does notadjust the market weight of a cell to cover a broad market but insteaduses the number of bonds in the cell as a weighting mechanism (e.g., thenumber of bonds that go into a cell are selected to achieve the desiredweighting relative to the broader market or index). Of note, thestandard deviation of sizes in each cell may, as a matter of practice incertain cases, “wash away”, wherein using the number of bonds forweighting essentially mirrors the results of market weighting.

[0129] In another embodiment of the present invention a bond issuerwhich could fit in one or more industry sectors (i.e., a“conglomerate”), is placed in a single industry sector.

[0130] In another embodiment of the present invention a bond issuerwhich could fit in one or more industry sectors (i.e., a“conglomerate”), is placed in multiple industry sectors.

[0131] In another embodiment of the present invention the SpreadVolatility test utilizes the universe of all bonds available in themarket.

[0132] In another embodiment of the present invention the MarketProfiling may be carried out annually, the Rebalancing may be carriedout monthly, the broad index may be priced daily, and the liquid indexmay be priced in real-time or in quasi-real-time.

[0133] In another embodiment of the present invention performance of aliquid, tradable index may be measured using one or more of thefollowing metrics: (a) tracking (how well does the liquid, tradeableindex track a broad market or index); (b) transaction cost (relating tothe total number of bonds that turnover [in one example, which exampleis intended to be illustrative and not restrictive, the turnover may be⅔, or 20 for a 30 bond index]); (c) volumetric turnover (bidbid/offer tobid [in one example, which example is intended to be illustrative andnot restrictive, this value may be about 70 basis points per year]); (d)diversity (e.g., Moody's diversity score [in one example, which exampleis intended to be illustrative and not restrictive, diversity may beabout 15.2 for a 30 bond index, wherein a higher score is better]); (e)incumbency premium (in one example, which example is intended to beillustrative and not restrictive, this value may be {fraction (60/40)}[within issuer/outside issuer]); (f) front loading (e.g., a bond entersthe liquid, tradeable index the same month that the bond issues [in oneexample, which example is intended to be illustrative and notrestrictive, this value may be about ⅔]); (g) turnover period by period(this value may be qualitative); and (h) bonds selected are acceptableto one or more reviewers (this may be qualitative).

[0134] In another embodiment of the present invention the incumbencypremium associated with the Liquidity Score may be determined asfollows: Bonds that were members of the liquid index in at least theprior month may be assigned an incumbency premium to their LiquidityScore to reflect the notion that a new entry candidate would have tooutscore an incumbent by a reasonable margin of additional liquidity inorder to justify the expense of the trade. In addition, such incumbencypremium may help to control turnover. In any case, in one specificexample (which example is intended to be illustrative and notrestrictive) the incumbency premium may be +6.0. More particularly:

[0135] The incumbency premium may stay constant for a new liquid indexentrant for a “honeymoon” of x number of months (e.g., 4 months), andthen the incumbency premium may begin to decay according to:exp(−0.3×(incumbent months honeymoon))×6.0.

[0136] All other bonds from an issuer who has an incumbent bond may alsoreceive a premium equal to 2.4×exp(−0.3×(incumbent months−honeymoon)[where honeymoon=0]. This “intra-issuer incumbency premium” may helpfacilitate moves to the on-the-run bond within a large complex of debtfrom a single issuer.

[0137] In another embodiment of the present invention the MarketProfiling, the Annual Updating, the Selection Process, and/or the BondWeighting associated with one or more indices (e.g., a broad indexand/or a liquid index) may operate as follows:

[0138] Market Profile. Profile the broad market across industry sectorand maturity dimensions. The Market Profile may be a 3×3 matrix, e.g.:5-10-30 years to maturity on one axis, and Financial-Telecom-Other onthe 2^(nd) axis (the intersection of each of these 3 elements may thusproduce a final matrix of 9 cells).

[0139] Annual Update. Generate a new annual profile (e.g., everyNovember 1, a date which corresponds roughly to the end of theunderwriting season) as follows: The bonds in the broad index arescattered into the matrix, and the number of bonds in each cell isrecorded. The proportionally equivalent number of bonds for the liquidindex is then computed and recorded. That number stays constant for oneyear. Because underwriting effects during the year will change thefundamental composition of the broad market, do not load up the entireliquid index according to the matrix guideline. Instead, try to assign15 bonds for the matrix based on this profile, subject to the conditionslaid out below with reference to the Selection Process.

[0140] Selection Process. The finalized qualified entrant list isrank-ordered according to final Liquidity Score (which Liquidity Scorehas been described above) and the top x (e.g., 30 to 100) bonds arechosen in the following three phases:

[0141] a) First pass: The top x (e.g., 30 to 100) bonds are chosen, xper issuer (e.g., 1, 2, or 3), based on full 3-factor liquidity scores(that is, raw score+incumbency premium+issuer premium).

[0142] b) Second pass: The initial set of choices is then checkedagainst the Market Profile matrix, which assigns a preferred bond countfor each cell of the cube. A cell represents a cross-section ofmaturity, and industry sector. The goal of the matrix is to keep thenumber of bonds in each such cross-section, or cell, roughlyproportionally representative of the broad market. The matrix is alsoused later in the algorithm to weight the bonds in a manner that isproportionally representative of the broad market (Bond Weightingbelow). For any cell that is underrepresented, a scan is made of theunselected bonds from that cell. If a bond is available that is y%(e.g., 90%) of the Liquidity Score of a bond in the current top queuefrom another cell, the swap is executed.

[0143] c) Third pass: A second swapping routine similar to the cellrepresentation logic is then applied to test that each “element” on thematurity dimension of the matrix has at least x (e.g., 5) bonds. If agiven element is underrepresented, a scan is made of the unselectedbonds from that element, and if one can be found that is y% (e.g., 90%)of the Liquidity Score of a chosen bond from another element, the swapis executed.

[0144] d) To help diversify the product's credit risk, no more than xissues (e.g., 1, 2, or 3) per issuer may enter.

[0145] Bond Weighting. The base market weight of each chosen bond isthen adjusted according to the following methodology (as opposed tobeing equal price weighted as discussed above):

[0146] a) Each bond in the broad index is placed into the appropriatecell in the matrix, and each bond in the liquid index is placed into asecond matrix of the same design. The cell factors (see b below) fromthe prior month are applied to the current bonds. The percentage oftotal market value for each cell 1-9 relative to the market value of thetotal matrix is recorded for both matrices.

[0147] b) Factors are created for each element of each dimension of theMarket Profile matrix−six in total. The product of any pair of suchfactors, selected from the two different matrix dimensions, defines acell factor. The cell factors are used to adjust the market sizes of theliquid index bonds in each one of the 9 cells. During rebalancing, theprior month factors are first applied. If the total market sizepercentages for the individual rows or columns of the liquid indexmatrix profile have drifted from the broad ones by less than x% (bysubtraction), wherein x% is 2.5%, for example, the old factors remain inplace for the current month. This reflects the notion that the cost ofincurring the friction to buy additional securities only becomesworthwhile when tracking error is materially endangered. New factors arecomputed otherwise by solving a simultaneous set of equations to forcethe drift down to zero.

[0148] In another embodiment of the present invention the following bondselection criteria may be used. In one specific example (which exampleis intended to be illustrative and not restrictive), the broad index maybe composed of euro-, euro-legacy-currency-, or sterling-denominatedbonds issued by corporate issuers and rated by either (or both) Moody'sand S&P. The index composition may be eligible for periodic rebalancingat a desired time (e.g., once a month). In one specific example (whichexample is intended to be illustrative and not restrictive), therebalancing may occur after the close of business on the last businessday of the month.

[0149] More particularly, in one specific example (which example isintended to be illustrative and not restrictive), for a bond to beincluded in the index (and/or remain in the index), the bond may have tomeet the criteria described below at month-end:

[0150] Candidates:

[0151] Bonds denominated in euros (or any European legacy currency) orthe British pound.

[0152] Geographic scope: The issuer or the issuer's guarantor (in thecase of a finance subsidiary) may have to be domiciled or have most ofits operations in Japan, Western Europe, or North America.

[0153] New issues may have to have been settled before the rebalancingdate to be included in the index for the next period. In one example(which example is intended to be illustrative and not restrictive), onlybonds issued after Jan. 1, 1997, may be considered.

[0154] Preferreds, perpetuals, and floating rate notes may not enter theindex however, bank capital step-ups that have this form may enter ifthe other rules are satisfied.

[0155] Convertibles may not be considered as part of the candidateuniverse.

[0156] The information for the selection of the bonds and theircorresponding rating may be derived from the Bondware informationservice and/or the ISMA information service, each of which may becomplemented by using it in conjunction with any further relevant marketinformation.

[0157] In one example (which example is intended to be illustrative andnot restrictive), for a bond to enter and/or remain in the index, theremaining time to the bond's maturity may have to be equal to or greaterthan x year(s) (e.g., 1 to 3 years).

[0158] Quality:

[0159] The bond may have to be rated by S&P and/or Moody's. In onespecific example (which example is intended to be illustrative and notrestrictive), the index may not include non-rated securities.

[0160] Any existing credit ratings may have to be consistent with theindex in which the bond will be classified, for example:

[0161] High yield: below investment grade but not in default (BB+ orlower by Standard & Poor's and Ba1 or lower by Moody's)

[0162] Investment Grade: above high yield

[0163] In one specific example (which example is intended to beillustrative and not restrictive), an investment grade index may notinclude split-rated (e.g., Baa3/BB+ or Ba1/BBB) issues.

[0164] In one specific example (which example is intended to beillustrative and not restrictive), issues rated D by S&P or that havebeen subject to a default press release by Moody's may not enter theindex; those issues in the index that are subsequently downgraded to Dby S&P or subject to a default press release by Moody's may be taken outof the index on the next rebalancing date.

[0165] Minimum Size:

[0166] The outstanding face value of the bond must be greater or equalto: 500 million in one example, 500 million equivalent in anotherexample, 200 million in another example, 200 million equivalent inanother example, 100 million in another example, 100 million equivalentin another example, 60 million in another example, and 60 millionequivalent in another example (wherein each example is intended, ofcourse, to be illustrative and not restrictive)

[0167] Bond Type:

[0168] Fixed coupon schedule: floating rate notes may be excluded (bankcapital being a possible exception to this rule, as noted above).

[0169] Step-ups with a coupon structure that changes on fixed dates oris a function of the issuer's rating may be included, as long as theformula and schedule are known at issuance. Deferred coupon bonds, zerocoupon bonds, PIKs (pay-in-kinds) may be included as well.

[0170] In one specific example (which example is intended to beillustrative and not restrictive), bonds with warrants attached may notbe included in the index.

[0171] Monthly Rebalancing:

[0172] The composition of the index may be held constant for any givencalendar month to ensure continuity during the month and to avoid jumpsunrelated to the price movements of the bonds.

[0173] In one specific example (which example is intended to beillustrative and not restrictive), the inclusion and exclusion criteriaabove may be applied at month-end, after the close of business. If abond conforms to all criteria listed above at month-end, it may beincluded in the index calculations for the next month. Bonds that werein the index, but that no longer satisfy all the criteria at month-end,may be removed from the index.

[0174] If a bond becomes eligible in the middle of the month, it maystill need to pass the test at the end of the month, and may only beincluded upon rebalancing at month end.

[0175] When a bond is called, it may remain in the index at its callprice until the end of the month, after which it may be removed.

[0176] Changes in issue size that take place during the month may betaken into consideration only at the next rebalancing date.

[0177] Subindices:

[0178] The bonds composing the subindices may be a subset of the bondsin the composite indices, and therefore have to pass the sameeligibility tests.

[0179] Rating Comment for the Quality Sector Subindices (AAA, AA, A,BBB, BB, B, and CCC):

[0180] If a bond is rated by only one agency (e.g., Moody's or S&P), orif both agencies classify it in the same quality sector, it may beincluded in the corresponding quality sector subindex. For bonds withsplit ratings: the lower rating may prevail for Investment Grade indicesand the higher rating may prevail for the High Yield indices.

[0181] Rating Migration from One Index to The Other:

[0182] In one specific example (which example is intended to beillustrative and not restrictive), bonds that are split rated(investment grade/high yield) with the ratings differing between Moody'sand S&P may not be part of either an investment grade index or a highyield index. In this example, a bond may only be included if bothagencies classify it in the same universe—or if it is only rated by oneagency.

[0183] In one example (which example is intended to be illustrative andnot restrictive), after a bond has migrated into investment grade(Rising Star) or high yield (Fallen Angel) from the other universe, itmust remain x months (e.g., 3 months) in the new universe before it canbe included in an index at the next following rebalancing date. Thisrule is intended to reduce volatility in the composition of the twoindices, and to allow for the market participants to assess its fairvalue and credit worthiness.

[0184] In another embodiment, a tradeable, liquid, and balanced creditindex according to the present invention may use the followingmulti-pronged bond selection methodology.

[0185] In one prong of the bond selection approach the index structuremay be determined as follows in this specific example (which example isintended to be illustrative and not restrictive):

[0186] The index may be composed of a predetermined number of bonds(e.g., 30 to 100). This number is assuming, of course, that there areenough bonds available in the market that satisfy all selectioncriteria. In any case, the bonds in each index may form a subset of thebonds included in a corresponding aggregate index. The index structuremay be based on market framework which seeks representation along xdimensions (e.g., 3) of the market (such as sector, ratings andmaturity, for example (which example is intended to be illustrative andnot restrictive)) and the index may seek to track the structure of acorresponding bond market (e.g., a corporate market). A ReferenceProfile for this purpose may be redefined periodically (e.g., monthly)as those bonds that constitute the corresponding aggregate index. Thiscan help to ensure that the Reference Profile broadly evolves with thecurrent trends in the market. To seek representation and balance, theindex may comprise a minimum number of bonds proportional to thepercentage of bonds found in the market along the above-mentioneddimensions.

[0187] In an alternative prong of the bond selection approach the indexstructure may be determined as follows in this specific example (whichexample is intended to be illustrative and not restrictive):

[0188] The index may be composed of a predetermined number of bonds(e.g., 30 to 100). This number is assuming, of course, that there areenough bonds available in the market that satisfy all selectioncriteria. In any case, the bonds in each index may form a subset of thebonds included in a corresponding aggregate index. The index structuremay be based on market framework which seeks representation along xdimensions (e.g., 3) of the market (such as sector, ratings andmaturity, for example (which example is intended to be illustrative andnot restrictive)) and the index may seek to track the structure of acorresponding corporate bond market. A Reference Profile for thispurpose may be redefined periodically (e.g., monthly) as those bondsthat constitute the corresponding aggregate index. This can help toensure that the Reference Profile broadly evolves with the currenttrends in the market. Subsequently, issuers are selected who are themost representative of the market size and/or market capitalization.Then, at least one representative issue is selected from each of theselected issuers—maximizing liquidity. The resulting bond yields thenhave their weights adjusted to meet the profile of the desiredmarket—wherein the weights are a function of both the total debtoutstanding for the issuer and the adjustment of the three dimensionalmodel to fit the desired market.

[0189] In the next prong of the bond selection approach, the selectionof specific bonds may be carried out as follows in this specific example(which example is intended to be illustrative and not restrictive):

[0190] While the structure of each index may be constant for apredetermined interval (e.g., a whole year), the bonds comprising theindex to “fill the matrix” may be chosen at a more frequent interval(e.g., at the end of every month) according to the following criteria:

[0191] Only bonds that are represented in a corresponding aggregateindex may enter into the index. The minimum size of the issues in theindices may be: 500 million in one example, 500 million equivalent inanother example, 200 million in another example, 200 million equivalentin another example, 100 million in another example, 100 millionequivalent in another example, 60 million in another example, and 60million equivalent in another example (wherein each example is intended,of course, to be illustrative and not restrictive)

[0192] To discriminate among bonds, a Liquidity Score may be imputed toeach bond. As discussed above, the Liquidity Score may be a function of,among other things, the bond's size, the total issuance size of allbonds from that issuer in the index, and the bond's age. In one specificexample (which example is intended to be illustrative and notrestrictive), the higher the bond's and the issuer's outstandingamounts, and the lower the age, the higher the Liquidity Score.

[0193] In a specific example (which example is intended to beillustrative and not restrictive), a bond may be preferred to anotherone if the first bond has a higher Liquidity Score; however, bonds whichwere in the index in the previous period may receive a premium to theirLiquidity Score in order to reduce turnover to cases where imputedliquidity is stronger beyond a preset threshold.

[0194] In one specific example (which example is intended to beillustrative and not restrictive), only one issue per issuer may beincluded in any index, unless it is part of another cell (e.g.,different maturity or different rating (if these define different cellsfor that index)).

[0195] In another embodiment of a credit index according to the presentinvention, an index value calculation methodology may comprise thefollowing procedure:

[0196] Calculations:

[0197] For the aggregate indices, the index may be treated as aportfolio where each bond's weight is equal to its marketcapitalization. In one specific example (which example is intended to beillustrative and not restrictive), calculations may be made on a dailybasis, using bid or ask prices (with reference to the market conditionsprevailing at that time in that market (e.g., 6 p.m. London time or 3p.m. New York time)).

[0198] Total Return:

[0199] The components of the total return may include price changes,accrued interests, coupon payments, and reinvestment income on cashflows received in the middle of the period. In one specific example(which example is intended to be illustrative and not restrictive), thetotal return may be first computed on a daily basis for each single bond“i” following the formula:

TR _(i)=((P1−P0)+(A1−A0)+C*(1+r*nb days/d))/(P0+A0), where

[0200] P0=Clean (flat) price at the beginning of the period (if the bondis new that period then P0 is offer; if the bond is incumbent thatperiod then P0 is bid).

[0201] P1=Clean (flat) price at the calculation date (always bid)

[0202] A0=Accrued interest at the beginning of the period

[0203] A1=Accrued interest at the calculation date

[0204] C=Coupon payments received (note that this cash flow does notinclude repayments of the bond's par amount outstanding at the callprice when a bond is called)

[0205] r=Euro or GBP one-month LIBID rate at coupon payment date

[0206] d=Day count convention for the reference LIBID instrument.

[0207] Then, a market-capitalization-weighted average of the individualtotal returns may be calculated using the beginning-of-the-period marketvalue of each bond i as follows:

[0208] Index TR=Σ_(i)TR_(i)×Weight_(i), where

[0209] Weight_(i)=Par Amount_(i)×Dirty Price_(i)/(Σ_(i)ParAmount_(i)×Dirty Price_(i)) taken at the last rebalancing date.

[0210] Index Value:

[0211] All indices and subindices may be set at 100 at inception.

[0212] The index value at month-end may be the compounded value of themonthly returns. Therefore, in one specific example (which example isintended to be illustrative and not restrictive) the formula:

[0213] Index Value=100×Π_(t) (1+TR_(t)), where TR_(t) are the totalreturns calculated for the past months since inception may be used.

[0214] During the month, the index value may be calculated by applyingthe total return since the start of that month to the index level at thelast rebalancing date. Therefore, in one specific example (which exampleis intended to be illustrative and not restrictive), the formula may beas follows:

Index Value_(Current)=Index Value_(Rebalancing Date)×(Index TR)

[0215] The index may be reweighted on a monthly basis using bondissuance, call and tender, and/or other relevant information.

[0216] Geographic scope of the indices:

[0217] In one specific example (which example is intended to beillustrative and not restrictive), the bonds may come from issuers inWestern Europe, North America and Japan. More particularly, in thisexample, only bonds from the following countries may be included in theindices: Andorra, Austria, Belgium, Denmark, Faeroe Islands, Finland,France, Germany, Gibraltar, Greece, Iceland, Ireland, Italy,Liechtenstein, Luxembourg, Malta, Monaco, Netherlands, Norway, Portugal,San Marino, Spain, Sweden, Switzerland, United Kingdom, Vatican CityState, United States, Canada, or Japan.

[0218] Referring now to FIG. 12, a diagram depicting a “net gaintesting” process according to an embodiment of the present invention isshown. As seen in this FIG. 12, the net gain testing is utilized to testwhether a number of proposed transactions would result in a netLiquidity Score gain to an index. More particularly, in one exampleoperation (which example is intended to be illustrative and notrestrictive), if Bond#1 comes into Cell#4 and “knocks out” Bond#2,Bond#3 must also come out of Cell#5 and be replaced by Bond#4 (Bond#3must come out when Bond#1 goes in because Bond#1 and Bond#3 are issuedby the same issuer and in this example only one issue per issuer ispermitted in the index). The net gain testing process will not allowthese transactions to proceed unless the change in the average LiquidityScore for the index is positive (i.e., unless the sum of the LiquidityScores of the incoming bonds is greater than the sum of the LiquidityScores of the outgoing bonds).

[0219] Of note, this FIG. 12 depicts a 2×3 matrix (5 years, 10 years,and 30 years on one axis and Financial and Non-Financial on the otheraxis) for the purposes of illustration only, and any other desiredmatrix size and/or composition may, of course, be utilized. Further,while the net gain testing process is described with reference to FIG.12 in connection with a 1 issue per issuer case, such net gain testingmay, of course, be utilized with other cases (e.g., 2, 3, or more issuesper issuer). Further still, in another example the net gain testing maypermit a number of transactions as long as the net result is not a lossin average Liquidity Score for the index (i.e., if the net gain ispositive or zero).

[0220] In another embodiment data from an NASD sponsored program called“TRACE” (designed to provide trading related data on essentially everyapplicable bond trade) may be utilized. More particularly, data fromTRACE may be utilized in the calculation of a Raw Score and/or aLiquidity Score according to the invention (and/or the data from TRACEmay be utilized to verify a Raw Score and/or a Liquidity Score). In thisregard, it is noted that the TRACE data may be utilized in one example,which example is intended to be illustrative and not restrictive, todetermine how prices move from trade to trade. In another example of howsuch TRACE data may be utilized (which example is intended to beillustrative and not restrictive), it is noted that the frequency withwhich an instrument (such as a bond) trades may aid in providing anindication of liquidity.

[0221] In another embodiment data from program(s) other than TRACE whichprovide trading related data and/or data from other sources (e.g.,investment institutions other than the sponsor of a broad index and/or aliquidity index) may be utilized in the calculation of a Raw Scoreand/or a Liquidity Score according to the invention (and/or such datamay be utilized to verify a Raw Score and/or a Liquidity Score).

[0222] In another embodiment a credit index (e.g., a liquid creditindex) is provided which is periodically rebalanced and tradeable.

[0223] In another embodiment a system and method are used forstructuring a credit index (e.g., a liquid credit index) which isperiodically rebalanced and tradeable.

[0224] In another embodiment a system and method are used for operatinga credit index (e.g., a liquid credit index) which is periodicallyrebalanced and tradeable.

[0225] In another embodiment a system and method are used fordetermining the liquidity of a credit, such as a bond.

[0226] In another embodiment a mechanism for structuring and/oroperating a rule-based modified market capitalization weighted index ofbonds is provided.

[0227] In another embodiment a mechanism is provided for rankingliquidity.

[0228] In another embodiment a credit index (e.g., a liquid creditindex) is provided which utilizes a mechanism for ranking liquidity.

[0229] In another embodiment if there are not enough bonds initiallyavailable to populate the liquid index (e.g., if there are insufficientbonds available in the market and/or in the broad index which meet therequirements of the liquid index) then the liquid index may be populatedwith as many bonds as possible and periodic re-profiling (e.g., monthly)may be carried out until the liquid index is fully populated.

[0230] In another embodiment a software program for determining aliquidity score associated with a bond issued by an issuer is provided,comprising: means for determining a raw score which is a function of theage and size of the bond; means for determining a model issuer premiumassociated with the issuer; means for determining an applied issuerpremium associated with the bond, which applied issuer premium is basedat least in part on the model issuer premium; and means for combining atleast the raw score and the applied issuer premium to determine theliquidity score.

[0231] In another embodiment a software program for populating an indexof a plurality of bonds, each of which bonds is issued by an issuer isprovided, comprising: means for disqualifying any of the bonds in aninitial candidate subset of bonds from inclusion in the index of bondsfor one or more disqualifying conditions; means for determining aliquidity score for each of the bonds in the initial candidate subset ofbonds which is not disqualified, wherein said liquidity score isdetermined at least in part by: (a) determining a raw score which is afunction of the age and size of the bond; (b) determining a model issuerpremium associated with the issuer; (c) determining an applied issuerpremium associated with the bond, which applied issuer premium is basedat least in part on the model issuer premium; and (d) combining at leastthe raw score and the applied issuer premium to determine the liquidityscore; means for segmenting the bonds in the initial candidate subset ofbonds into a matrix; and means for including one or more bonds from theinitial candidate subset of bonds in the index of bonds based at leastin part upon the liquidity score of the included bond and a position ofthe included bond in the matrix associated with the initial candidatesubset of bonds.

[0232] While a number of embodiments of the present invention have beendescribed, it is understood that these embodiments are illustrativeonly, and not restrictive, and that many modifications may becomeapparent to those of ordinary skill in the art. For example, theanalytic data provided via the web-based interface may includeperformance data (such as performance summary, performance attribution,best/worst performers, sector weightings, relative value analysis, andspread movements shown against their 60-day trading range, for example).Further, such performance data may be given on a comparative basis (suchas across industries, for example,) and may be shown in graph form.Further still, the present invention may be employed in the context ofan Index Mutual Fund (i.e., a mutual fund composed of one or moredifferent indices), wherein each index may use liquid underlyingcomponents (e.g., credits). Further still, while the present inventionhas been described principally with respect to a method for structuringand/or implementing a credit index (and/or a Liquidity Score), acorresponding software program and/or system may of course be utilizedto structure or help to structure a credit index and/or to implement orhelp to implement a credit index and/or to structure or help tostructure a Liquidity Score and/or to implement or help to implement aLiquidity Score. Further still, the present invention may be employedwith a “basket” of financial instruments and the disclosure abovemodified accordingly. Further still, the broad index used as a candidatepool for the liquid index of the present invention may utilize anydesired operating rules (e.g., bonds must settle prior to the first ofthe month in order to enter for that month; bonds are assigned tospecific issuer entities by a sponsor and/or administrator associatedwith the broad index; and/or bonds are coded into the industry taxonomyby a sponsor and/or administrator associated with the broad index).Further still, the Market Profile matrix may comprise what is sometimereferred to mathematically as a “hyper-cube”. Further still, the RawScore may be calculated as a planar regression (e.g., against volumedata). Further still, any of the functions and/or constants disclosedherein could be changed or modified according to tests on actual dataand/or simulations. Further still, the Liquidity Score of the presentinvention may be used on its own (i.e., not in connection with anindex), wherein the Raw Score and/or Issuer Premium components are usedto calculate the Liquidity Score without reference to the IncumbencyPremium component. Further still, the act of including a credit in anindex according to the present invention (e.g., a liquid, tradeableindex) may increase the liquidity of the credit.

What is claimed is:
 1. A software program for determining a liquidityscore associated with a bond issued by an issuer, comprising: means fordetermining a raw score which is a function of the age and size of thebond; means for determining a model issuer premium associated with theissuer; means for determining an applied issuer premium associated withthe bond, which applied issuer premium is based at least in part on themodel issuer premium; and means for combining at least the raw score andthe applied issuer premium to determine the liquidity score.